Understanding the 5% Rule for Rent vs Buy Decisions

Evan Willoughby

When you’re weighing whether to keep paying a landlord or to buy a place of your own, the 5 percent rule is often the first shortcut people reach for. It suggests that if a property’s annual rent exceeds 5% of its purchase price, renting is financially smarter; if it’s lower, buying may be the better move.

Why the 5% rule matters

The rule boils down to a quick sanity check. It forces you to compare two big numbers: the total cost of owning a home (including mortgage, taxes, maintenance) and the amount you’d spend on rent each year. If the rent figure is higher than the 5% threshold, the extra cash you’d lock into a mortgage could be put to work elsewhere, potentially earning more.

Breaking down the numbers

To use the rule you need three core inputs:

1. Purchase price of the home you’re eyeing.
2. Annual rent you’d pay for a comparable rental.
3. The 5 percent benchmark, which is simply 0.05 × purchase price.

If annual rent > 5 % × purchase price, renting wins the quick test.

What the rule leaves out

While handy, the 5% rule skips many real‑world factors that can swing the decision.

• Mortgage interest rate - A low rate can shave years off your loan cost, making buying more attractive.
• Property appreciation - If home values rise fast in your area, the equity you build can outpace rent savings.
• Tax deductions - Mortgage interest and property tax deductions lower your effective cost of ownership.
• Inflation - Rent tends to climb with inflation, while a fixed‑rate mortgage stays the same.
• Opportunity cost - The money you’d put down as a down‑payment could be invested elsewhere (stocks, bonds, etc.) and potentially earn a higher return.
• Cash flow - Owning means monthly mortgage, insurance, and maintenance outflows; renting is a single payment.

Quick calculation example

Imagine a two‑bedroom house listed at NZ$800,000 in Auckland. The 5% benchmark is NZ$40,000 per year, or roughly NZ$770 per week in rent.

Current market rent for a similar unit is NZ$850 per week (NZ$44,200 per year). Because NZ$44,200 > NZ$40,000, the rule says rent is cheaper.

But let’s add a few layers:

• Mortgage rate: 5.2 % (30‑year fixed)
• Down‑payment: 20 % (NZ$160,000)
• Annual property appreciation: 3 %
• Tax deduction on mortgage interest: saves about NZ$3,500 per year
• Potential investment return for the down‑payment: 6 % in a diversified portfolio

When you run a full cash‑flow model, buying might actually edge out renting after about 7‑8 years, despite the simple rule’s “rent” verdict.

Comparison table

When the 5% rule works best

Use the rule as a first filter if you’re short on time or data. It’s most reliable in markets where:

• Rent prices are stable and transparently listed.
• Property values haven’t surged dramatically in the past few years.
• Mortgage rates are near historical averages.

If those conditions hold, the rule can spare you a long spreadsheet.

When to dig deeper

Ignore the rule if any of these apply:

• You expect strong appreciation (e.g., upcoming infrastructure projects).
• You have a low‑interest mortgage locked in.
• You can claim significant tax benefits or have a high‑yield investment alternative for the down‑payment.
• You value the stability of owning over the flexibility of renting.

In those cases, a full cash‑flow analysis will give a clearer picture.

Key takeaways

• The 5 percent rule compares annual rent to 5 % of a home’s price.
• It’s a quick sanity check, not a final verdict.
• Mortgage rates, appreciation, tax deductions, and opportunity cost can flip the result.
• Use it for a first look; follow up with a detailed model if the numbers are close.
• Every market is different - adjust the benchmark if local data suggests a better threshold.